LP Co-Investment Rights in Venture Capital and Private Equity

Co-investment rights have become an increasingly important feature in venture capital and private equity fund agreements, allowing Limited Partners (LPs) to invest directly in portfolio companies alongside the main fund. This article explores the key aspects of LP co-investment rights, their benefits, challenges, and practical implications for both investors and fund managers.

Understanding Co-Investment Rights

Co-investment rights give LPs the opportunity to make direct investments in portfolio companies outside of their primary fund commitment. These rights are typically negotiated during fund formation and outlined in the Limited Partnership Agreement (LPA) or side letters.

Key Characteristics

Investment Structure: Co-investments are usually made directly into portfolio companies, parallel to the main fund's investment, often through a separate vehicle.

Fee Arrangements: Co-investments typically come with reduced fees or no fees at all, in contrast to the traditional "2 and 20" model applied to fund investments. This usually means:

• No management fees

• No carried interest

• Only direct expenses related to the co-investment

Investment Size: Co-investment opportunities usually range from 10% to 50% of the deal size, depending on the fund's strategy and deal specifics.

Benefits for Limited Partners

Economic Advantages

• Lower fee burden enhances potential returns

• Accelerated capital deployment compared to traditional fund investments

• Opportunity to increase exposure to attractive deals

• Better alignment with specific investment preferences

Strategic Benefits

• Direct exposure to private company investments

• Enhanced relationship with General Partners (GPs)

• Greater transparency into investment process

• Potential for deeper market insights

Benefits for General Partners

Enhanced Deal Execution

• Ability to pursue larger deals

• Reduced burden on fund concentration limits

• Additional capital source for attractive opportunities

Strengthened LP Relationships

• Deeper engagement with key investors

• Potential for future fundraising success

• Improved alignment of interests

Common Structuring Approaches

Pro-Rata Rights: Example: Fund X commits to invest $100M in Company A

• Total deal size: $150M

• Fund allocation: $100M

• Co-investment rights: Up to $50M offered to LPs on a pro-rata basis

Strategic Allocation: Example: Large Pension Fund LP Agreement

• Priority co-investment rights up to 25% of each qualifying deal

• Minimum deal size: $200M

• Notice period: 15 business days

Key Considerations and Challenges

For Limited Partners

Decision-Making Timeline

• Quick turnaround requirements (often 10-15 business days)

• Need for efficient internal approval processes

• Resource allocation for due diligence

Risk Management

• Concentration risk in single investments

• Limited governance rights

• Reduced diversification compared to fund investments

For General Partners

Allocation Policies

• Fair and transparent process for offering co-investments

• Managing potential conflicts between different LPs

• Documentation and compliance requirements

Execution Complexity

• Additional administrative burden

• Coordination with multiple co-investors

• Potential impact on deal timing

Best Practices for Implementation

Documentation Requirements

Co-Investment Agreement

• Investment terms and conditions

• Governance rights

• Exit provisions

• Transfer restrictions

Side Letter Provisions: Example Language:

"The LP shall have the right to participate in co-investment opportunities

alongside the Fund in accordance with the following terms:

(i) Pro-rata participation rights based on commitment size

(ii) No management fees or carried interest on co-investments

(iii) 15 business day notice period for decision-making"

Process Management

Deal Notification

• Standardized communication protocol

• Clear timeline for response

• Required information package

Due Diligence Support

• Access to data room

• Management presentations

• Third-party reports

Market Trends and Evolution

Increasing Standardization

• More formal allocation policies

• Standardized documentation

• Established market practices

Technology Integration

• Digital platforms for co-investment management

• Automated notification systems

• Online due diligence tools

Future Outlook

The co-investment landscape continues to evolve with:

• Growing LP sophistication in direct investments

• Enhanced regulatory scrutiny

• Development of secondary market for co-investments

Co-investment rights have become a standard feature in venture capital and private equity fund agreements, offering benefits to both LPs and GPs. Success in co-investment programs requires careful consideration of structure, process, and resources. As the market continues to mature, we expect to see further refinement of best practices and increased sophistication in implementation approaches.